Why Startups Needn't Be Depressed

A startup depression? Nah. Jason's missive notwithstanding, I'm seeing something distinctly different. Sure, it's harder to raise money. Sure, the osmotic effect of bad feelings in the public markets and the job market challenge one's optimism and perspective. But net net, opportunities abound, the same if not better opportunities than before the financial markets started to melt down.

The crisis forces the survivors to place an even greater emphasis on efficiency, customer intimacy, value creation and relevance. Historical ways of doing business are being challenged by new ways of accessing content, the push towards open-source solutions, the different ways in which influence is created and disseminated and the high-value goods and services being created and delivered from low-cost, offshore sources. In today's world you are either moving forward or moving backward - stasis is not an option. Inertia is death. And it is at this intersection of creativity, intensity, customer knowledge and cost efficiency where start-ups can step into the breach. And they are.

The entrepreneurs I see every week are filled with energy, passion, good ideas and a laser focus on keeping costs low, not because the environment sucks but because they know this is they way it should be done. Develop a prototype. Put it in front of users/customers. Set a product development road map based on modest resource assumptions, rapid product iterations, intensive user feedback and a financing goal 12-18 months out. From this comes milestones that can be used for product planning, staffing, going-to-market and financing. Pretty similar, in fact, to the 10 points Jason raises in his post. His points are all really good points. But I don't see them as points related to today's environment. I see them as they way entrepreneurs should be establishing and running their businesses, all the time.

So if you run or work in a startup company that is backed by well established venture capital firms, take a brief sigh of relief and then immediately get working on the "leaner, focused, profitable" mantra and drive toward those goals relentlessly.

If, on the other hand, you are just starting a company, or have angels backing you, or are backed by first time venture firms that are not funded by traditional sources, then I think you've got a bigger problem on your hands. It's not an impossible problem to solve, but you have to start thinking about how you are going to get where you want to go without venture funding.

I say that because in down market cycles, it's the seed and startup stage investing that dries up first. It happens every time. Seed/startup investing is most profitable early in a venture cycle and late stage investing is most profitable late in a venture cycle. It makes sense if you think of venture capital as a cyclical business, and it is very cyclical. Early in a cycle you want to back young companies at bargain prices and enjoy the demand for those companies as the cycle takes hold. Late in a cycle you want to back established companies that need a "last round" to get to breakeven and you can get that at a bargain price compared to what others paid before you. I've been in the venture capital business since 1986 (that was a down cycle) and I've seen this happen at least three times, probably four times now.

There's another important reason why seed and startup investing dries up in down cycles. Venture firms don't need to spend as much time on their existing portfolio companies when things are going well. A rising market hides a lot of problems. But when things go south, they tend to become inwardly focused. I believe we are headed into a period where venture firms will spend more time on their existing portfolio and less time adding new names to it.

Now Fred has seen a lot more of this than I have, and I agree completely with what he's saying. New start-ups shouldn't be focused on getting that institutional round done because the bid may simply not exist. But I also think that the angel and seed stage investment community is far more developed and far deeper than it was even back in 2001-03. There are groups of ex-Googlers, DoubleClickers, and many other savvy entrepreneurs that enjoyed successful exits who are putting money to work in early-stage deals, and these groups have deep pockets, are real value-added, and can help down-cycle start-ups with both revenue generation and strategies for surviving another VC nuclear winter. While not exactly like a classic VC, they can bring many of the same benefits to the table with a greater appetite for risk.

So am I saying "it's different this time"? I suppose I am. I'm not sure how many people like me were around doing deals 6-8 years ago, but I can say for sure that there are a lot more of me now then there were only four short years ago. And these people know that risk-adjusted returns on seed stage investing are very attractive, and that valuations will become increasingly rational as the sources of liquidity dry up. We're not going anywhere. And as long as that's the case, excellent start-up prospects will continue to get funded and grow, even in today's hostile environment. So don't get too depressed, because the strong will continue to get funded, survive and thrive. And the weak? Well, it will be a quicker and less painful death, and that is a good thing, too.